DAVID GREENE, HOST:
This is MORNING EDITION from NPR News. Good morning to you. I'm David Greene.
The two most powerful entities in the housing market, Fannie Mae and Freddie Mac, could be on the verge of making a significant change. It involves one of the most politically explosive debates surrounding the housing crisis: whether to reduce the amount of money struggling homeowners owe on their mortgages.
We've learned that each firm has conducted a new internal analysis. Their conclusion: Loan forgiveness wouldn't just help keep hundreds of thousands of families in their homes; it would also save Freddie and Fannie money.
The story you're about to hear from NPR's Chris Arnold was co-reported with Jesse Eisinger of ProPublica.org.
CHRIS ARNOLD, BYLINE: This is a big development in a charged political issue. That's because some economists, and many Democratic lawmakers, see principal reduction as a powerful tool for helping the housing market.
DR. MARK ZANDI: Principal reduction works. If someone gets a reduction in their principal amount, it gives them a real powerful hook to really fight to try to hold on to the home and not go into foreclosure.
ARNOLD: Mark Zandi is chief economist of Moody's Analytics. He says here's how this works: If someone is struggling to pay a $200,000 mortgage on their house and the house is only worth $150,000, they might decide to just walk away - and many people do. But if their lender forgives $50,000 of what they owe, that's often a game-changer. And Fannie and Freddie guarantee and control most of the home loans in the country. So...
ZANDI: I think if Fannie and Freddie fully committed to the idea of doing more principal reduction mods, that we'd see several hundred thousand - three to 500,000 - in principal reduction mods over the course of the next several years of Fannie and Freddie loans. And that would make a substantive difference.
ARNOLD: That's three to 500,000 homeowners getting a big break on their mortgage. Zandi thinks that that could do a lot to tip the housing market towards recovery and thereby, help the whole economy. That's the argument for doing this. Other economists disagree. And Fannie and Freddie's regulator has so far refused to allow this approach.
That regulator is Ed Demarco. He's the head of the Federal Housing Finance Agency, or FHFA. And he controls Fannie and Freddie following a giant federal bailout. At a recent Senate hearing, Demarco said he wants to prevent foreclosures.
ED DEMARCO: But we need to do so in a way in which we are meeting our mandate to protect the taxpayers.
ARNOLD: In other words, he needs to be a good steward of taxpayer money. Last month, DeMarco testified that both companies, Fannie and Freddie themselves, told him that they didn't support principal reductions.
DEMARCO: Both companies have been reviewing principal forgiveness alternatives. Both have advised me that they do not believe it is in the best interest of the companies to do so.
ARNOLD: But now, Fannie and Freddie appear to be saying the opposite. In part, that's because the Obama administration has recently tripled the incentives it offers to lenders who do these principal write-downs. And so now, in many cases, if a lender writes off, say, $50,000 worth of principal, the government will reimburse half of that - $25,000.
That's a lot of taxpayer money. Many Republican lawmakers don't like that, and some economists hope that DeMarco stands his ground.
ANTHONY SANDERS: I think DeMarco is absolutely right.
ARNOLD: Anthony Sanders is a professor at George Mason University. He says that if Fannie and Freddie start forgiving big chunks of what people owe on their mortgages, they risk triggering a huge wave of strategic defaults. That is, people who don't really need the help defaulting on purpose to try to get it.
SANDERS: Once you throw in principal reductions as a carrot...
(SOUNDBITE OF LAUGHTER)
SANDERS: ...people will then pretend they have to go into default, just to get the principal reduction.
ARNOLD: Critics say that could result in a near cataclysmic mess, where hundreds of thousands of people could stop paying their mortgages; they'd flood their lenders with calls, stumbling over each other to try to get free money.
SANDERS: And that's going to take a lot of manpower to try to sort through these who actually needs one, and actually - who just wants to get, you know, a principal write-down at taxpayer expense. This could blossom into something really ugly.
ARNOLD: Still, the private sector has already been doing many more principal write-downs; by one count, 15 percent of all recent loan modifications. And, proponents say, so far the sky's not falling because of that.
For his part, Ed Demarco told NPR in a statement that the FHFA is now considering these new incentives, and whether they change his agency's prior analysis of principal reduction. He also said, quote: Fannie Mae and Freddie Mac continue to offer a broad array of assistance to troubled borrowers.
Meanwhile, political pressure on DeMarco is building, at least from Democrats. More than a hundred lawmakers have signed a letter asking him to reconsider and allow principal reduction, to save taxpayer money and prevent foreclosures.
Chris Arnold, NPR News.
GREENE: This story was reported together with Jesse Eisinger of ProPublica.org.
NPR transcripts are created on a rush deadline by a contractor for NPR, and accuracy and availability may vary. This text may not be in its final form and may be updated or revised in the future. Please be aware that the authoritative record of NPR's programming is the audio.